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PayPal's Revenue Growth Continues Unabated

Still image from video demonstrating the ease of use of PayPal subsidiary Xoom's remittance app. Image source: PayPal Holdings Inc.

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If there's a single takeaway in the third-quarter 2016 earnings report from digital-payments facilitatorPayPal Holdings Inc.(NASDAQ: PYPL) that came out Oct. 20, it's that PayPal isn't having much trouble sustaining a revenue growth rate in the high teens. We'll delve in a moment into the metrics driving top-line growth, as well as management's expectations for the next three years. But first, let's take in the view from 30,000 feet.

Customer interest in social payments app Venmo continued to blossom. The app, which, among other functions, allows friends to easily split restaurant checks, continued to post torrid growth. Venmo's TPV of $4.9 billion during the quarter translates to a year-over-year growth rate of 131%.

Operating margin decreased 160 basis points to 13% in Q3 2016. PayPal's take rate (total revenue divided by total payments volume) has been declining in the past few quarters as Venmo's peer-to-peer transaction volume, which is not yet fully monetized, has increased. In addition, the company's Braintree subsidiary is enjoying higher volume, although its revenue is dependent on credit card transactions, which tend to be slightly less profitable than the company's overall transaction margin.

Lower margins inject a dose of reality into an otherwise heady report. However, management tends to see this as a favorable trade-off in the interests of aggressively advancing the organization's top line.

PayPal issued positive if minor adjustments to its full-year 2016 outlook. The company raised its expected revenue range by $30 million, to a new band of between $10.78 billion and $10.85 billion. Earnings-per-share guidance for 2016 was also lifted, from between $1.11 to $1.14 per diluted share to a new estimate of between $1.13 and $1.15 per diluted share.

In its earnings release, PayPal declared its enthusiasm over numerous agreements signed during the quarter, most notably transaction partnerships inked with Visa(NYSE: V) and MasterCard(NYSE: MA). Yet on management's conference call with analysts, executives were careful to note that digital wallet partnerships with card issuers will take time to implement, and they signaled that the company wouldn't see a material revenue boost in 2017 from the Visa and MasterCard deals.

PayPal announced that it will make its remittances app Xoom available to PayPal customers, thus opening the ability of PayPal users to send money to 10 new markets, as well accessing Xoom services in over 50 countries.

What management had to say

PayPal's management believes the transaction giant has several avenues to growth for the foreseeable future. This outlook is due both to the company's focus on expanding its customer base and the sheer size of the market it operates within. CEO Dan Schulman summed it up this way on the company's earnings conference call:

In the past two years, in the face of one competitive announcement after another we have attracted $35 million net new active accounts. Our engagement per active account has grown from 24 to 30 times per year. Our merchant base now totals $15 million active accounts. And our mobile payments volumes and unique innovative capabilities continue to drive our growth.

We believe the partnerships we have signed enable us clearly, predictably, and profitably to pursue the $100 trillion total addressable market that is fully but surely digitizing. I believe we now have the platform, capabilities, scale, and partnerships to enable us to drive profitable growth, not just next year but over the medium and long term.

This outlook essentially promises to keep current growth rates intact. PayPal also sees free cash flow expanding at a constant rate with revenue. The company has been generating exceptional cash flow as of late: In Q3, PayPal recorded $618 million in free cash flow, which equaled 23% of revenue.

In other words, PayPal converted nearly a quarter of every revenue dollar into cash after capital expenditures were paid for. With this kind of efficiency, the company should have ample funds to reinvest in the business, potentially sustaining its enviable growth rate beyond the next three years.

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